Sticky Expectations and the Profitability Anomaly

We propose a theory of the “profitability” anomaly. In our model, investors forecast future profits using a signal and sticky belief dynamics. In this model, past profits forecast future returns (the profitability anomaly). Using analyst forecast data, we measure expectation stickiness at the firm level and find strong support for three additional model predictions: (1) analysts are on average too pessimistic regarding the future profits of high‐profit firms, (2) the profitability anomaly is stronger for stocks that are followed by stickier analysts, and (3) the profitability anomaly is stronger for stocks with more persistent profits.     

PURE INDICATOR OF RISK APPETITE

We study the concept of risk appetite, that is investors' willingness to buy risky assets. Market players and researchers have tried to find a proxy for it, notably by means of spreads in high yielding markets like credit or emerging markets. However, these measures might be biased because they hinge on series of prices that include market movements due to the re-pricing of both systemic and specific risks. Being macro factors that affect all the assets in the universe, risk appetite and risk aversion can only produce systemic risk re-pricing. We apply a methodology to correct this bias. We analysed emerging market debt capital markets and compute a systemic risk only indicator that enables one to ascertain more precisely periods in which risk appetite might have driven market returns. We find that from the end of 1997 to 2004 only about 30 per cent of the return of the EMBI+ might have been due to changes in risk appetite.     

Debt Stabilizing Fiscal Rules

Unstable government debt dynamics can typically be stabilized around a certain target level of debt by adjustments in various fiscal instruments, like government spending, transfers, or taxes. This paper investigates properties of debt stabilizing rules which link the needed budgetary adjustments to the state of the economy. The paper establishes that the magnitude of the target level of long‐run debt is a key determinant of whether it is possible to find a rule of this type that can be implemented under all available fiscal instruments. Specifically, considering linear feedback rules, the paper demonstrates that there may well exist a critical target level of debt beyond which this is no longer possible. From an applied perspective, this finding is of particular relevance in the context of a monetary union with decentralized fiscal policies. Depending on the target level of debt, there might be a conflict between a common fiscal framework that tracks deficit developments as a function of the state of the economy and the unrestricted choice of fiscal policy instruments at the national level.     

Credit Contagion from Counterparty Risk

Standard credit risk models cannot explain the observed clustering of default, sometimes described as "credit contagion." This paper provides the first empirical analysis of credit contagion via direct counterparty effects. We find that bankruptcy announcements cause negative abnormal equity returns and increases in CDS spreads for creditors. In addition, creditors with large exposures are more likely to suffer from financial distress later. This suggests that counterparty risk is a potential additional channel of credit contagion. Indeed, the fear of counterparty defaults among financial institutions explains the sudden worsening of the credit crisis after the Lehman bankruptcy in September 2008.     

Capital Accumulation and Fiscal Policy in an OLG Model with Family Altruism

The idea of family altruism is that parents care only about their children's income and not about the use of this income made by the children. First, we establish dynamical properties which place the OLG model with family altruism halfway between the model with pure life‐cyclers ( Diamond 1965 ; American Economic Review 55, 1126–1150) and the one with dynastic altruism ( Barro 1974 ; Journal of Political Economy 82, 1095–1117). Then, we show that this concept leads to interesting fiscal policy conclusions less clear‐cut and more realistic than those obtained with the two previous standard OLG models: a pay‐as‐you‐go social security is neutral but not a public debt.     

On Environmental Policy and Permitting

The literature on environmental policy under adverse selection usually assumes that firms' profit vary monotonically with a private information parameter. However, it is easy to demonstrate using standard production setups that regularity is not the rule. We show that policy requirements are very sensitive to this assumption. In particular, the optimal instrument resembles more an “adaptable” pollution standard than the economic instrument of an environmental tax. We also show that permitting, which results in some firms overinvesting in pollution‐control equipment, does not serve the objective of improving the environment but rather allows the agency to increase the proceeds of the policy.     

Have We Underestimated the Likelihood and Severity of Zero Lower Bound Events?

Prior to the financial crisis, most economists probably did not view the zero lower bound (ZLB) as a major problem for central banks. Using a range of structural and statistical models, we find that previous research understated the ZLB threat by ignoring uncertainty about model parameters and latent variables, focusing too much on the Great Moderation experience, and relying on structural models whose dynamics cannot generate sustained ZLB episodes. Our analysis also suggests that the Federal Reserve's asset purchases, while materially improving macroeconomic conditions, did not prevent the ZLB constraint from having first‐order adverse effects on real activity and inflation.     

Majority Voting in Multidimensional Policy Spaces: Kramer–Shepsle versus Stackelberg

We study majority voting over a bidimensional policy space when the voters’ type space is either uni‐ or bidimensional. We study two voting procedures widely used in the literature. The Stackelberg (ST) procedure assumes that votes are taken one dimension at a time according to an exogenously specified sequence. The Kramer–Shepsle (KS) procedure also assumes that votes are taken separately on each dimension, but not in a sequential way. A vector of policies is a Kramer–Shepsle equilibrium if each component coincides with the majority choice on this dimension given the other components of the vector. We study the existence and uniqueness of the ST and KS equilibria, and we compare them, looking for example at the impact of the ordering of votes for ST and identifying circumstances under which ST and KS equilibria coincide. In the process, we state explicitly the assumptions on the utility function that are needed for these equilibria to be well‐behaved. We especially stress the importance of single‐crossing conditions, and we identify two variants of these assumptions: a marginal version that is imposed on all policy dimensions separately, and a joint version whose definition involves both policy dimensions.     

STABILIZATION POLICY, LEARNING-BY-DOING, AND ECONOMIC GROWTH

This paper shows that fiscal policy, when used for stabilizationpurposes, can have a positive effect on the economy's growth,on human capital accumulation, and on welfare. We introducestochastic productivity shocks into a model in which productivityis augmented through learning-by-doing If future benefits oflearning-by-doing are not fully internalized by workers, thenrecessions are periods in which opportunities for acquiringexperience are foregone. We identify configurations of disturbancesand other parameters for which a countercyclical policy maximizesgrowth and welfare.     

Purchasing Power Parity in the Long Run

This paper re-examines the evidence on Purchasing Power Parity (PPP) in the long run. Previous studies have generally been unable to reject the hypothesis that the real exchange rate follows a random walk. If true, this implies that PPP does not hold. In contrast, this paper casts serious doubt on this random walk hypothesis. The results follow from more powerful estimation techniques, applied in a multilateral framework. Deviations from PPP, while substantial in the short run, appear to take about three years to be reduced in half.